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With the average venture closing costing more than $50,000 and with the bills being paid for all parties by the investors, there appears to be a conflict of interest. AND, there is. A number of my entrepreneur friends have commented how they feel under-represented when it comes to the many issues relating to a closing. A common complaint is that their lawyers cave on important yet small issues that come back to haunt them months or years later. So, what is actually going on"

First, it's important to keep in mind that any competent venture lawyer makes a lot more from venture capitalists than from any one company, especially in the early stages. If a venture lawyer really fought for your interests, they would risk being blackballed by VCs from doing other venture deals. Imagine a VC saying that will not work with your lawyer. What would you do" Fire them, of course. Hmmm. Second, there is always a rush to get the deal done these days after a cumbersome diligence process, which forces the company to compromise. Lastly, every point that you fight as a company costs you double, since the bill for everyone comes out of the fundraising proceeds. It's like losing a full time employee, a marketing campaign, and nicer offices to make the terms reasonable. Ouch!

The best you can do as an entrepreneur is to come to the table prepared with your eyes open, and this takes a decent amount of tedious research BEFORE you get your first terms. Terms that appear harmless on paper, like a mandatory cumulative dividend, can eat away at your returns as a founder and make your life much more complicated as you do later rounds. You need to know what the terms mean in good times and in bad, and you need to be prepared to lead the fight directly during the term sheet negotiation. Don't rely on your advisors, as that is a craps shoot.

Fortunately, there are resources to help. The best overview that I have found is a tediously long document by the law firm of Fenwick and West, outlining all of the terms, sample outcomes, historical data, and even sample term sheets. Here is a link to the 70-add page document:

It is far too common for entrepreneurs, whether they are seasoned or inexperienced, to get nailed by some unexpected term. It's the unbridled optimism that nails the seasoned guys, thinking that they can beat the 3x clearing for participation, for example. I certainly have been nailed. Does any other Members have some resources or opinions to share"

Posted by
RichieBlueEyes
on 2007-12-14

Lawyers are great - when they are on your side. They are horrible when you are just a toad in their collection of clients. Find an honest lawyer and become friends. You need someone on your side. At the end of the day, the term sheet will come down to negotiation, I would rather have a shark of a lawyer who has my interest at heart negotiating the terms then me. Why" He can get away with being an ass and I can't. Pretty simple, eh"

I feel like I have been suckered into starting LLC's by law firms over and over again, and here is what happens every time: (1) it costs twice as much to get all of the papers done, (2) we start growing and need to layer in complex partnership concepts for the equivalent of employee options, (3) we have to convert to a C Corporation to take any real external financing, and (4) the conversion costs twice as much as you expect since you need to transform a convoluted partnership structure into an equity structure.

Using an LLC structure for a fast growing start-up seems like a trick play to generate ten or twenty times the legal fees. My next company is going to be a corporation, starting with an S corp for preferential tax treatment and migrating to a C corp when the business starts to scale. Any other thoughts on this strategy are welcomed in the feedback.

Posted by
blackfish
on 2007-06-22

The Funded should create a section of the site dedicated to which venture lawyers to use and which to avoid. As the company is paying for both their counsel and the VC's counsel, it would be nice to have a resource to find out what you're in for.

[Comment from TheFunded.com] Not a bad idea. If we get over 50 agreements with this post, we will work to add such a section. [End Comment]

When you hear the comment that this term sheet / shareholder agreement is an industry standard you should be very cautious. There are no standards. The phrase means that there are clauses that even the VC feels a bit uncomfortable presenting (or don't think that you will approve them).